The Promise — and Perils — of Dynamic Pricing

Mobile app developer Atom Tickets has market-tested dynamic pricing in movie theaters, flush from a $50 million investment round led by The Walt Disney Co., Lionsgate and 21st Century Fox. With more than four billion movie seats going unoccupied each year, translating to substantial lost revenue, the goal was to find a pricing mechanism to fill those seats.

Atom’s test market could potentially set the stage for movie theaters to adopt dynamic pricing, which means setting prices according to real-time demand for goods or services. And while dynamic pricing has been around for decades, its use is expanding into new industries beyond travel and commodities, as executives seek out new ways to maximize revenues.

Atom, a Santa Monica, California-based start-up, tested its social media app in three markets, according to The Wall Street Journal. The tests were conducted at two major theater chains, Regal Entertainment Group and Carmike Cinemas.

But some experts are skeptical that dynamic pricing like that used in the Atom experiment will spread to other movie theater chains like AMC Entertainment Holdings, or ticketing agencies like Fandango. Indeed, a spokeswoman for Atom said the app won’t feature dynamic pricing when it is launched nationally this year.

“I’m not sure the movie industry will see dynamic pricing happen right away. Although people are used to paying lower prices for matinees and more for weekends, I don’t see people willing to pay different prices for the same movie, offered at the same time, in the same location,” says Senthil Veeraraghavan, Wharton professor of operations, information and decisions, who co-wrote a paper on dynamic pricing of professional sports teams.

Leonard Lodish, Wharton emeritus professor of marketing, points to another flaw in the concept. By dropping the price incrementally, it could hurt demand for those movie-goers who would have been willing to pay full price. “If you lower the price 10 minutes before the show starts, you will likely get the same number of people showing up for the movie,” says Lodish, who wrote a paper on dynamic pricing as it applies to broadcast spot pricing.

“Many more industries are aware of dynamic pricing, and customers are becoming aware that these things happen and it’s gaining social acceptance.”–Senthil Veeraraghavan

But George Lawrie, vice president and principal analyst serving application development and delivery professionals at Forrester Research, does not discount the idea. He believes dynamic pricing could be adopted by theaters if they have the data, applications and infrastructure to implement it effectively.

Dynamic Pricing Catalysts

Changes in technology and a greater acceptance of dynamic pricing among consumers are prompting more industries to consider deploying this type of pricing mechanism, even though the concept has been around for more than 30 years, Veeraraghavan says.

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Uber is a prime example of dynamic pricing being applied to a new service beyond the usual products in travel and hospitality. The transportation app, which lets consumers hire a private car service, adjusts prices depending on demand, time of day the trip is taken, whether it is raining or snowing and other conditions. And people are getting used to it. “We are in the beginning of the acceptance stage,” says Peter Fader, a Wharton marketing professor who co-wrote the dynamic pricing paper along with Veeraraghavan.

There is definitely more interest in dynamic pricing in the marketplace. “I get more calls than I used to from companies about exploring dynamic pricing, or expressing interest in it,” Veeraraghavan says. “The number of calls is still small, but it’s growing very fast. Every month, I meet at least one person or company that wants to explore this, and there are also more discussions going on in the classroom about this.”

Other examples of growth in dynamic pricing can be found with Qcue, a dynamic pricing software vendor, which signed up one client in 2009, according to Forbes. Three years later, Qcue’s client roster has ballooned to more than 30 in Major League Baseball, the National Basketball Association, the National Hockey Association and Major League Soccer.

Liftopia, a cloud-based e-commerce company, is also on a fast-growth track. The company was founded in 2005 to offer ski resorts the ability to dangle discounts before customers who purchased lift tickets in advance, similar to discounts given in the travel industry. Since it was founded, the company has signed up ski resorts in 36 states, eight Canadian provinces and 15 foreign countries.

Sports Embraces Dynamic Pricing

Sports is one industry that is increasingly embracing dynamic pricing to maximize revenue as demand ebbs and flows. For example, the San Francisco Giants in 2009 pioneered the concept of dynamic pricing for Major League Baseball when it offered lower prices for certain seat locations using Qcue’s software. Since then, the New York Mets, St. Louis Cardinals and Utah Jazz have adopted some form of dynamic pricing.

“If you lower the price 10 minutes before the show starts, you will likely get the same number of people showing up for the movie.”–Leonard Lodish

The Cardinals, for example, use a dynamic pricing program tied to its ticketing system in which the team changes ticket prices daily based on such factors as pitching match-ups, weather, team performance and ticket demand. The team also informs ticket buyers that this form of dynamic pricing provides fans with more price options and that in 69% of the 2015 games, tickets could be purchased for $10 or less. “Sports teams have done it smartly and with common sense,” says Wharton’s Fader.

But dynamic pricing in sports can backfire. The paper Fader co-authored with Veeraraghavan and Joseph Xu that discovered a weakness: Overall revenue actually decreased by 0.79% if prices were not allowed to freely decline even if circumstances — such as poor team performance — warranted it. If prices were allowed to move up and down freely, revenue would have increased by 14.3%, their paper said.

Performing arts is another area in the entertainment industry for which Veeraraghavan believes dynamic pricing would work, along with other segments of the travel industry beyond the airlines and cruise sectors.

The retail industry also may be ripe for dynamic pricing, says Lawrie of Forrester. He notes that businesses with a high proportion of fixed costs as well as limited capacity may be well suited for dynamic pricing. “Arguably, this is also true for seasonal retail or fashion, in which the merchant commits capital to buying a line of stock that must be cleared before the next season,” he adds.

Adopting Dynamic Pricing

When should a company adopt dynamic pricing? Several factors come into play in making that decision, and they vary widely, say experts.

“The way dynamic pricing is communicated to the consumer and corporate customer will affect their acceptance.”–Chris Fletcher

“There are many types of dynamic pricing,” says Greg Girard, program director of world-wide omni-channel retail analytics strategies for IDC. He notes four kinds that most companies are likely to come across: Yield or revenue management, fixed rules-based pricing, conditional rules-based pricing and personalized pricing.

Yield or revenue management pertains to dynamic pricing that is based on supply and demand and customers pay different amounts for the same item. The airline industry has been doing this for roughly 20 years, with cruise ships, hotels and car rentals later jumping in. The price for the same airline seat can vary day to day, based on demand.

With fixed rules-based pricing, prices are determined based on the time of the day, day of the week, or week within a season. The restaurant industry has used this form of pricing for its “early bird” specials, for example. Even though demand may not be there on a given Monday, the “early bird” special price will still be offered.

Conditional rules-based pricing differs from the previous two in that it is based on certain conditions occurring, such as what a competitor is doing with pricing, or whether a product is perishable, such as a piece of fruit.

Finally, personalized pricing is a pricing mechanism that is based on a customer’s characteristics. For example, compared with business travelers, leisure travelers are more likely to have increased flexibility to change their travel schedule. As a result, an airline may offer more discounted pricing to a leisure traveler to prevent him or her from using another airline since he or she has a flexible schedule, whereasbusiness travelers may be charged more since they are stuck using certain flights at certain times of the day.

Executives who are considering developing a dynamic pricing structure should pay attention to three key criteria, notes Chris Fletcher, a Gartner research director. These three qualities apply whether the client is a consumer or business: It must be digital, dynamic and defensible.

Digital means the pricing is automated with the help of algorithms. “Essentially, this means complex analytic capability pulling insight and pricing recommendations from big data,” Fletcher says. Being dynamic calls for pricing to adjust in real time, or near real time, to changes in demand, inventory, competitive activity and other inputs, he adds. Lastly, pricing needs to be defensible to the customer. Companies must communicate the methodology and reasoning behind the determination of the prices, and demonstrate that their pricing is consistent and applied fairly across all customers, Fletcher says.

“As a seller, you have to communicate why you are pricing it [using] dynamic pricing and what is in it for them,” Gartner’s Fletcher notes. “The way dynamic pricing is communicated to the consumer and corporate customer will affect their acceptance.”

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Additional Reading

Marketing

Based on simple demand curve equations, using discounts to move inventory that might otherwise go to waste is an easy choice. But factor in the human element and you can see any number of reasons to be afraid.